Written By: Milja Mieskolainen

The advancement of the banking institution, fueled by two industrial revolutions, paved the way for changes in the coming century. In the 19th century, for the first time, people were able to start saving creating a need for investment opportunities. As has been the case for centuries, people wanted to increase their wealth. Banks were a place to deposit savings but provided unreliable returns. The 20th century saw great leaps in the field of investment theories and important new concepts emerged.  This post outlines some of the key developments in chronological order. The last part of the history series deals with company-specific history.

Louis Bachelier (1870-1946) was a French mathematician also known as the father of mathematical finance.  He received this well-deserved acknowledgment only after his death like many others. In his dissertation, Bachelier had identified the mathematical relationship of the accumulation function to the diffusion equation ( Wiener process ), which is the basis of Einstein’s “ Brownian Motion ” article. In the field of investment, Bachelier's most important consideration was in determining the value of derivatives. He used the “Wiener process” to determine the value of the option, from which Bachelier derived its price, and which is now known as the so-called Barrier option. More than 70 years later, Black & Scholes described the share price as a statistical process (Geometric Brownian Motion, with drift ), based on the work of both Einstein and Bachelier.

Irving Fisher (1876-1947) is known for his work as an economist, and especially for capital theory. He was also involved in the development of the Modern Monetary Theory. In his book The Purchasing power of Money, Fisher developed a connection between money reserves and the general price level. According to him, the value of the dollar should be determined by the value of gold, and not just by its weight. The value of gold would be obtained from an index number. From an investment perspective, Fisher’s main theory relates to interest rates. He believed that interest was made up of two parts: people's time preference, according to which people like the result they get more now than in the future, and the principle of the opportunity to invest, which means the opportunity for an investment made now to generate a better return in the future. Fisher defined capital as generating income over time and showed its value based on the net income generated.

Nobel laureate Paul Samuelson (1915-2009) is known as one of the most significant economists of the 20th century. Samuelson was known for developing scientific analysis in economics based on his research and work in several different fields. Examples of Samuelson's achievements in economics include the adjustment of international trade to general economic equilibrium, the development of a mathematical form between coefficient effects and catalysts, and the theory of Revealed Preferences. In terms of financial theory, Samuelson was involved in developing the efficient market hypothesis. He sought to prove the existence of an efficient market as well as the fact that instrument prices follow a “random walk” with mathematical models.

Born in 1927, Harry Markowitz is another Nobel Prize winner. In 1952, he wrote an article on portfolio theory that appeared in the Journal of Finance. His theories highlighted the importance of portfolios, risks, correlations between instruments, and diversification. Markowitz didn’t consider investing in just one asset sensible: There are two criteria, risk and return, so it makes sense for an investor to choose a Pareto-efficient combination of the two. In his theory, he used a combination of the concepts of risk, return, variance, and covariance on the basis of diversification, and thus formed the concept known as the efficient frontier. Later, Markowitz’s ideas were refined into the Capital Asset Pricing Model (CAPM).

The history of investing has been full of notable individuals, and the four above are just a fraction of them. Theories evolved throughout the Great Recession in the 1930s and the world wars, but in the second half of the 20th century, modernization accelerated. Financiers took steps towards innovation, independence, and entrepreneurship. New instruments emerged, such as hedge funds (Alfred Winslow Jones 1949), private equity funds (American Research and Development Corporation 1946, Kohlberg Kravis Roberts 1978), venture capital (1956 from Silicon Valley), and REIT real estate investment funds (1960).

Index funds and ETFs were developed to be a simple and affordable investment opportunity. The first index fund was created by Jack Bogle Vanguard in 1976, and the first ETF, which reached great publicity, was developed in 1993. These funds simply seek to generate market returns without active portfolio management. Index funds and ETFs created a contrast to alternative investments, i.e. hedge and private equity funds, which emerged at the same time.

The 1980s and 1990s were influenced by the rise of the internet and modern methods of communication. In 1985, NASDAQ introduced its own index alongside Standard & Poor's. The index of 100 companies was the first to weight companies according to their market capitalizations. While it now seems strange that technology companies weren’t seen in traditional indexes, that was the reality before the introduction of the NASDAQ 100. As the popularity of this new index grew, the unexpected Dot-com bubble emerged. In the 1990s, this bubble burst, and the economy plunged into a global recession.

Today, most countries have their own stock market exchanges, which allows citizens to make easy investments. On the other hand, international players are only making it easier and easier to invest globally. New investment instruments and players are constantly entering the market, from which each investor can choose the most suitable for their preferences - some want to invest in real estate, others in shares, and some want to accumulate as diverse a portfolio as possible. Online, the stock market is accessed so quickly that investment history writes new numbers in seconds. The future is unpredictable, so it remains to be seen how lightning-fast innovations and the unprecedented growth in wealth will change the investment world.

More information on the topic:

Nb! Books can contain outdated knowledge but can help to understand the development of theories and provide new perspectives.

Irving Fisher: The Purchasing power of money + several other works

Harry Markowitz: Risk-Return Analysis: The Theory and Practice of Rational Investing and The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty